Foreclosures Spiraling Out Of Control

There has been enough talk about an impending next wave of foreclosures to suggest that indeed it’s going to happen. An article in the LA Times throws a little more information into the mix.

Just as the nation’s housing market has begun showing signs of stabilizing, another wave of foreclosures is poised to strike, possibly as early as this summer, inflicting new punishment on families, communities and the still-troubled national economy.

Amid rising unemployment and falling home prices, mortgage defaults have surged to record levels this year. Until recently, many banks have put off launching foreclosure action on the troubled properties, in part because they had signed up for the Obama administration’s home-stability plan, which required them to consider the alternative of modifying loans to make it easier for borrowers to make payments.

Just how big the foreclosure wave will be is unclear. But loan defaults are up sharply. And with many government and banks’ self-imposed foreclosure moratoriums expiring, the biggest lenders indicate that they are likely to move more aggressively to clear up a backlog of troubled mortgages.

I think the important information here is that the banks are reaching the point at which they are ready to start cleaning out the pipeline. Between state moratoriums and federal programs requiring them to consider modifications prior to foreclosure, the pace of resolution slowed. Having gone through the compliance phase, they’re now looking at an overwhelming amount of new inventory.

The Times article contains some useful data:

In the first quarter, some 1.8 million homeowners nationwide fell behind on their loans by 60 to 90 days, a 15% increase from the prior quarter, according to Moody’s Economy.com. The research firm said that loan defaults rose sharply as well, to 844,000 in the first three months of this year.

California accounts for an outsized share of mortgage loan defaults. A stunning 135,431 homeowners in the state were hit with notices of default in the first quarter, an increase of 11% from the earlier peak in the second quarter of 2008, according to real estate information service MDA DataQuick. Foreclosure sales in the state have been moderating after averaging a high of 26,500 a month last summer.

As I read those numbers, I don’t see any second derivatives at all. It appears as if the pace is accelerating. When you toss in the continuing decline in the employment picture — both increased joblessness and declining income for those still employed — it’s not at all unreasonable to assume that we aren’t near the bottom.

The earlier foreclosures, or the first wave if you will, most probably resulted from bad purchase or financing decisions. Homeowners who bought at the top of the market, or who bought too much house, or who got taken down by exotic financing or were done by a combination of all three. It was the natural result of a bubble unwinding and taking down the most aggressive players. In this second wave we’re probably seeing the harsh whip of the recession. Those being taken down now are being done in as much by economic distress as they are by housing bubble payback.

It’s a vicious downward spiral. As the economy deteriorates more are thrown into foreclosure and the more that are thrown into foreclosure, the more negative is the feedback loop to the general economy. Throw in those able to make payments but so far under water that they opt to strategically default and it becomes difficult to see the way out.

In the past I was an opponent of mortgage modifications. I’m not too sure that at this juncture something fairly radical might not be in order. We might be approaching a moment at which the only choice is to simply write-off big chunks of mortgages and restructure outstanding loans based on much lower principal balances. It will be a difficult and probably vastly unfair undertaking but the alternative of letting the market work through this seems to increasingly involve the risk of things spinning totally out of control.

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